Edgar Filing: ESSEX PROPERTY TRUST INC

form10-q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 001-13106

ESSEX PROPERTY TRUST, INC.

(Exact name of Registrant as Specified in its Charter)

Maryland		77-0369576
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

925 East Meadow Drive

Palo Alto, California 94303

(Address of Principal Executive Offices including Zip Code)

(650) 494-3700

(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the registrant is a large accelerated filer an accelerated file, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.

Yes o No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

26,795,274 shares of Common Stock as of October 30, 2008

ESSEX PROPERTY TRUST, INC.

FORM 10-Q

INDEX

		Page No.
PART I. FINANCIAL INFORMATION

Item 1.	Condensed Financial Statements (Unaudited):	3

	Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007	4

	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007	5

	Condensed Consolidated Statements of Stockholders' Equity and Comprehensive Income for the nine months ended September 30, 2008	6

	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	26

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	26

Item 1A.	Risk Factors	27

Item 6	Exhibits	28

Signatures		28

Index

Part I -- Financial Information

Item 1: Financial Statements (Unaudited)

"Essex" or the "Company" means Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, or where the context otherwise requires, Essex Portfolio, L.P., a limited partnership (the "Operating Partnership") in which Essex Property Trust, Inc. is the sole general partner.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of operations, stockholders' equity and comprehensive income and cash flows of the Company reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein. Additionally, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2007.

Index

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

(Dollars in thousands, except per share amounts)

	September 30,			December 31,
	2008			2007
Assets
Real estate:
Rental properties:
Land and land improvements	$	669,322		$	670,494
Buildings and improvements		2,485,788			2,447,265

		3,155,110			3,117,759
Less accumulated depreciation		(612,249	)		(541,987	)

		2,542,861			2,575,772
Real estate - held for sale, net		15,983			-
Real estate under development		347,979			233,445
Co-investments		66,363			64,191

		2,973,186			2,873,408
Cash and cash equivalents-unrestricted		33,404			9,956
Cash and cash equivalents-restricted		12,552			12,527
Marketable securities		58,614			2,017
Receivables from related parties		967			904
Notes and other receivables		45,782			49,632
Prepaid expenses and other assets		23,474			20,286
Deferred charges, net		11,347			11,593

Total assets	$	3,159,326		$	2,980,323

Liabilities and Stockholders' Equity
Mortgage notes payable	$	1,341,327		$	1,262,873
Mortgage notes payable - held for sale		10,799			-
Exchangeable bonds		225,000			225,000
Lines of credit		153,000			169,818
Accounts payable and accrued liabilities		64,759			52,783
Construction payable		20,089			5,365
Dividends payable		32,037			28,521
Other liabilities		16,672			17,773

Total liabilities		1,863,683			1,762,133
Commitments and contingencies
Minority interests		279,930			281,960
Cumulative convertible preferred stock; $.0001 par value:4.875% Series G - 5,980,000 issued and outstanding		145,912			145,912
Stockholders' equity:
Common stock, $.0001 par value, 649,702,178 shares authorized 24,943,675 and 24,876,737 shares issued and outstanding		2			2
Cumulative redeemable preferred stock; $.0001 par value:7.8125% Series F - 1,000,000 shares authorized, issued and outstanding, liquidation value		25,000			25,000
Excess stock, $.0001 par value, 330,000,000 shares authorized and no shares issued and outstanding		-			-
Additional paid-in capital		982,754			857,109
Distributions in excess of accumulated earnings		(122,044	)		(82,805	)
Accumulated other comprehensive income (loss)		(15,911	)		(8,988	)

Total stockholders' equity		869,801			790,318

Total liabilities and stockholders' equity	$	3,159,326		$	2,980,323

See accompanying notes to the unaudited condensed consolidated financial statements.

Index

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARES

Condensed Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Revenues:
Rental and other property	$	102,907		$	95,012		$	302,898		$	275,747
Management and other fees from affiliates		1,311			1,268			3,965			3,662
		104,218			96,280			306,863			279,409
Expenses:
Property operating, excluding real estate taxes		25,719			22,949			74,625			66,707
Real estate taxes		8,630			8,185			24,904			23,298
Depreciation and amortization		27,952			24,169			82,564			69,036
Interest		19,399			19,459			57,835			57,688
Amortization of deferred financing costs		686			701			2,109			2,054
General and administrative		6,524			6,415			19,600			18,519
		88,910			81,878			261,637			237,302

Earnings from operations		15,308			14,402			45,226			42,107

Gain on sale of real estate		2,446			-			2,446			-
Interest and other income		2,847			2,407			8,048			7,454
Equity income in co-investments		335			322			7,325			2,767
Minority interests		(5,666	)		(5,088	)		(16,929	)		(15,459	)
Income before discontinued operations		15,270			12,043			46,116			36,869
Income (loss) from discontinued operations (net of minority interests)		(584	)		265			(1,417	)		25,172
Net income		14,686			12,308			44,699			62,041
Dividends to preferred stockholders		(2,310	)		(2,311	)		(6,931	)		(6,864	)
Net income available to common stockholders	$	12,376		$	9,997		$	37,768		$	55,177

Per common share data:
Basic:
Income before discontinued operations available to common stockholders	$	0.52		$	0.39		$	1.58		$	1.23
Income (loss) from discontinued operations		(0.02	)		0.01			(0.06	)		1.03
Net income available to common stockholders	$	0.50		$	0.40		$	1.52		$	2.26
Weighted average number of common shares outstanding during the period		25,110,710			25,165,276			24,876,611			24,370,184

Diluted:
Income before discontinued operations available to common stockholders	$	0.51		$	0.38		$	1.56		$	1.20
Income (loss) from discontinued operations		(0.02	)		0.01			(0.06	)		1.01
Net income available to common stockholders	$	0.49		$	0.39		$	1.50		$	2.21
Weighted average number of common shares outstanding during the period		25,474,924			25,555,928			25,182,107			24,983,765

Dividend per common share	$	1.02		$	0.93		$	3.06		$	2.79

See accompanying notes to the unaudited condensed consolidated financial statements.

Index

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity and

Comprehensive Income for the nine months ended September 30, 2008

(Unaudited)

(Dollars and shares in thousands)

													Distributions
	Series F									Additional			in excess of			Accumulated other
	Preferred stock				Common stock					paid-in			accumulated			comprehensive
	Shares		Amount		Shares			Amount		capital			earnings			income (loss)			Total
Balances at December 31, 2007		1,000	$	25,000		24,877		$	2	$	857,109		$	(82,805	)	$	(8,988	)	$	790,318
Comprehensive income:
Net income		-		-		-			-		-			44,699			-			44,699
Change in fair value of cash flow hedges and amortization of swap settlements		-		-		-			-		-			-			(6,923	)		(6,923	)
Comprehensive income																				37,776
Issuance of common stock under:
Stock-based compensation plans		-		-		79			-		5,714			-			-			5,714
Issuance of common stock		-		-		1,131			-		133,654			-			-			133,654
Retirement of common stock		-		-		(143	)		-		(13,723	)		-			-			(13,723	)
Dividends declared		-		-		-			-		-			(83,938	)		-			(83,938	)
Balances at September 30, 2008		1,000	$	25,000		25,944		$	2	$	982,754		$	(122,044	)	$	(15,911	)	$	869,801

See accompanying notes to the unaudited condensed consolidated financial statements.

Index

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

	Nine Months Ended
	September 30,
	2008			2007
Net cash provided by operating activities	$	143,048		$	158,148

Cash flows used in investing activities:
Additions to real estate:
Acquisitions and improvements to recent acquisitions		(93,906	)		(333,110	)
Capital expenditures and redevelopment		(52,420	)		(52,124	)
Additions to real estate under development		(92,497	)		(96,236	)
Dispositions of real estate and investments		44,980			124,103
Changes in restricted cash and refundable deposits		(2,791	)		1,979
Purchases of marketable securities		(62,522	)		(5,843	)
Sales and maturities of marketable securities		5,925			-
Advances under notes and other receivables		(1,958	)		(19,192	)
Collections of notes and other receivables		5,980			1,472
Contributions to co-investments		(4,183	)		(22,164	)
Distributions from co-investments		9,423			15,330
Net cash used in investing activities		(243,969	)		(385,785	)

Cash flows from financing activities:
Borrowings under mortgage and other notes payable and lines of credit		565,096			665,709
Repayment of mortgage and other notes payable and lines of credit		(450,485	)		(494,331	)
Additions to deferred charges		(2,105	)		(1,516	)
Settlement of forward-starting swaps		(1,840	)		1,311
Net proceeds from stock options exercised		4,841			3,786
Net proceeds from sale of common stock		133,654			213,672
Repurchase of common stock		(13,723	)		(1,409	)
Distributions to minority interest partners		(18,128	)		(77,145	)
Redemption of minority interest limited partnership units		(12,304	)		(9,983	)
Common and preferred stock dividends paid		(80,637	)		(71,880	)
Net cash provided by financing activities		124,369			228,214

Net increase in cash and cash equivalents		23,448			577
Cash and cash equivalents at beginning of period		9,956			9,662
Cash and cash equivalents at end of period	$	33,404		$	10,239

Supplemental disclosure of cash flow information:

Cash paid for interest, net of $8.2 million and $3.6 million capitalized in 2008 and 2007, respectively	$	46,929		$	52,443

Supplemental disclosure of noncash investing and financing activities:
Mortgage note assumed by buyer in connection with sale of property	$	42,200		$	-
Mortgage note assumed in connection with land contribution	$	-		$	43,839
Mortgage note issued to buyer in connection with sale of property	$	4,070		$	-
Land contributed by a partner in a consolidated joint venture	$	10,500		$	22,200
Change in value of cash flow hedges and amortization of swap settlements	$	6,923		$	6,602
Change in construction payable	$	14,724		$	5,576
Issuance of DownREIT units in connection with purchase of real estate	$	-		$	7,067
Property received in satisfaction of note receivable	$	1,500		$	-

See accompanying notes to the unaudited condensed consolidated financial statements.

Index

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

September 30, 2008 and 2007

(Unaudited)

(1) Organization and Basis of Presentation

The unaudited condensed consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q. In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature, except as otherwise noted. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2007.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2008 and 2007 include the accounts of the Company and Essex Portfolio, L.P. (the "Operating Partnership", which holds the operating assets of the Company). See below for a description of entities consolidated by the Operating Partnership. The Company is the sole general partner in the Operating Partnership, with a 91.4% general partnership interest as of September 30, 2008.

As of September 30, 2008, the Company owned or had ownership interests in 133 apartment communities, (aggregating 26,790 units), six office buildings, and one manufactured housing community (containing 157 sites) (collectively, the “Properties”). The Properties are located in Southern California (Los Angeles, Orange, Riverside, Santa Barbara, San Diego, and Ventura counties), Northern California (the San Francisco Bay Area), and the Seattle metropolitan area.

Fund Activities

Essex Apartment Value Fund II, L.P. (“Fund II”) is an investment fund formed by the Company to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities.

Fund II has eight institutional investors, and the Company, with combined partner equity commitments of $265.9 million. The Company has committed $75.0 million to Fund II, which represents a 28.2% interest as general partner and limited partner. Fund II utilized leverage equal to approximately 55% upon the initial acquisition of the underlying real estate. Fund II invested in apartment communities in the Company’s targeted West Coast markets and, as of September 30, 2008, owned eleven apartment communities and three development projects. Essex records revenue for its asset management, property management, development and redevelopment services when earned, and promote income when realized if Fund II exceeds certain financial return benchmarks.

Marketable Securities

Marketable securities consist primarily of U.S. treasury or agency securities and tax-exempt variable rate demand notes with original maturities of more than three months when purchased. The Company has classified U.S. treasury and agency securities as held-to-maturity securities, and the Company reports these securities at amortized cost. The Company has classified the tax-exempt variable rate demand notes as available for sale and the Company reports these securities at fair value and any unrealized gain or loss is recorded as other comprehensive income (loss). Realized gains and losses and interest income are included in interest and other income on the condensed consolidated statement of operations.

Variable Interest Entities

In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46 Revised (“FIN 46R”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”, the Company consolidates a joint venture development project, 19 DownREIT limited partnerships (comprising twelve properties), an office building that is subject to loans made by the Company, and prior to the sale of the property during 2007, the buildings and improvements that were owned by a third-party subject to a ground lease on land that was owned by the Company. The Company consolidates these entities because it is deemed the primary beneficiary under FIN 46R. The consolidated total assets and liabilities related to these variable interest entities (“VIEs”), net of intercompany eliminations, were approximately $247.7 million and $168.4 million, respectively, as of September 30, 2008 and $222.7 million and $163.9 million, respectively, as of December 31, 2007. Interest holders in VIEs consolidated by the Company are allocated net income equal to the cash payments made to those interest holders for services rendered or distributions from cash flow. The remaining results of operations are generally allocated to the Company. As of December 31, 2007, the Company had two VIE’s of which it was not deemed to be the primary beneficiary. Total assets and liabilities of these entities were $71.7 million and $58.3 million, as of December 31, 2007. As of September 30, 2008, the Company did not have any VIE’s of which it was not deemed to be the primary beneficiary.

Index

Stock-Based Compensation

The Company accounts for share based compensation using the fair value method of accounting. The estimated fair value of stock options granted by the Company is being amortized over the vesting period of the stock options. The estimated grant date fair values of the long term incentive plan units (discussed in Note 14, “Stock-Based Compensation Plans,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007) are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $0.4 million for the three months ended September 30, 2008 and 2007, respectively, and $0.9 million and $1.0 million for the nine months ended September 30, 2008 and 2007, respectively. The intrinsic value of the stock options exercised during the three months ended September 30, 2008 and 2007 totaled $1.4 million and $2.2 million, respectively, and $4.1 million and $4.9 for the nine months ended September 30, 2008 and 2007. As of September 30, 2008, the intrinsic value of the stock options outstanding and fully vested totaled $15.1 million. As of September 30, 2008, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $4.7 million. The cost is expected to be recognized over a weighted-average period of 3 to 5 years for the stock option plans and 7 years for the restricted stock awards.

The Company adopted an incentive program involving the issuance of Series Z and Series Z-1 Incentive Units (collectively referred to as “Z Units”) of limited partnership interest in the Operating Partnership. Stock-based compensation expense for Z Units totaled $0.4 million for the three months ended September 30, 2008 and 2007, and $1.1 million for the nine months ended September 30, 2008 and 2007, respectively.

Stock-based compensation capitalized for stock options, restricted stock awards, and the Z Units totaled $0.2 million and $0.6 million for the three and nine months ended September 30, 2008 and 2007, respectively. As of September 30, 2008 the intrinsic value of the Z Units subject to conversion totaled $18.6 million. As of September 30, 2008, total unrecognized compensation cost related to Z Units subject to conversion in the future granted under the Z Units totaled $6.6 million. The unamortized cost is expected to be recognized over the next 3 to 11 years subject to the achievement of the stated performance criteria.

Stock-based compensation expense for the Outperformance Plan, (the “OPP”) adopted in December 2007 totaled approximately $0.3 million and $0.9 million for three and nine months ended September 30, 2008, respectively. Total unrecognized compensation cost less an estimate for forfeitures related to the OPP totaled $4.4 million as of September 30, 2008. The unamortized cost is expected to be recognized over the expected service period of five years for senior officers and three years for non-employee directors.

The Company’s stock-based compensation assumptions have not changed materially from information reported in Note 2(l), “Stock-Based Compensation,” and Note 14, “Stock-Based Compensation Plans,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Accounting Estimates and Reclassifications

The preparation of condensed consolidated financial statements, in accordance with U.S. generally accepted accounting principles, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate properties, its investments in and advances to joint ventures and affiliates, its notes receivable and its qualification as a Real Estate Investment Trust (“REIT”). The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.

New Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 provides guidance for using fair value to measure assets and liabilities. FAS 157 establishes a fair value hierarchy, giving the highest priority to quoted prices in active markets and the lowest priority to unobservable data. This statement is effective in fiscal years beginning after November 15, 2007. The adoption of this standard on January 1, 2008 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Index

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS No. 159”). FAS 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. This Statement is effective for fiscal years beginning after November 15, 2007. Through September 30, 2008, The Company has not elected to measure any eligible financial assets and liabilities at fair value.

In December 2007, the FASB issued revised FAS No. 141, “Business Combinations” (“FAS 141(R)”). FAS141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Management is currently evaluating the impact FAS 141(R) will have on the Company’s accounting for future business combinations.

In December 2007, the FASB issued FAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“FAS 160”). FAS 160 establishes accounting and reporting standards that require the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated balance sheet within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently; when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value; and entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. FAS 160 is effective for fiscal years beginning on or after December 15, 2008. Management is currently evaluating the impact FAS 160 will have on the Company’s condensed consolidated financial statements.

In May 2008, the FASB issued FASB staff position APB 14-1, “Accounting for Convertible Debt Instruments That May be Settled in cash upon Conversion (Including Partial Cash Settlement)” (“APB 14-1”). APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) upon conversion separately account for the liability (debt) and equity (conversion option) components of the instruments in a manner that reflects the issuer’s nonconvertible debt borrowing rate. APB 14-1 requires the initial debt proceeds from the sale of a company’s convertible debt instrument to be allocated between the liability component and the equity component. The resulting debt discount will be amortized over the period during which the debt is expected to be outstanding (i.e., through the first optional redemption dates) as additional non-cash interest expense. APB 14-1 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited and retroactive application is required for all periods presented. The interest expense from the Company’s $225.0 million exchangeable senior notes (the “Notes”) with a coupon rate of 3.625% due November 2025, which were issued in the fourth quarter of 2005, will be impacted by APB 14-1. Based on the Company's understanding of the application of APB 14-1, this will result in an additional non-cash interest expense of additional interest of approximately $4.0 million for 2008 and 2009, respectively. The Company will adopt APB 14-1 as of January 1, 2009, and the Company will present prior period comparative results reflecting the impact of APB 14-1.

(2) Significant Transactions

(a) Acquisitions

In July 2008, the Company acquired Chestnut Street Apartments, a 96-unit apartment community located in Santa Cruz, California, for $22.1 million. The property was built in 2002 and includes approximately 9,000 square feet of commercial and retail space. Also, during July the Company received seven condominium units with an estimated fair value of $1.5 million in full satisfaction of its participating loan made in 2005 to the buyer of Eastridge Apartments and, as a result, recognized $1.5 million of the previously deferred $2.2 million gain on sale of Eastridge Apartments.

In August 2008, the Company acquired The Highlands at Wynhaven, a 333-unit apartment community located in Issaquah, Washington for $66.3 million.

(b) Dispositions

During the third quarter of 2008, the Company sold Cardiff by the Sea Apartments, located in Cardiff, California for $71.0 million and St. Cloud Apartments, located in Houston, Texas for $8.8 million resulting in a combined gain of $46,000. The Company also sold the Circle recreational vehicle park for $5.4 million resulting in a gain of $0.9 million, and the Company sold the Vacationer recreational vehicle park for $4.6 million. The gain on sale of $0.8 million resulting from the sale of Vacationer was deferred due to the fact the Company loaned $4.1 million to the buyer at a fixed rate of 6.5% due in August 2011.

Index

During the third quarter of 2008, the Company issued 1,130,750 shares of common stock and during October 2008, the Company issued 78,300 shares at an average share price of $120.17. Since July 2008, the Company issued 1,209,050 shares of common stock for $142.8 million, net of fees and commissions. The Company will use the net proceeds to pay down debt, to fund the development pipeline and for future investments.

(d) Debt and Financing Activities

During July 2008, the Company paid-off an $89.0 million cross-collateralized mortgage loan at a fixed rate of 6.62%.

During August 2008, the Company obtained a mortgage loan in the amount of $53.0 million secured by Mill Creek, with a fixed rate of 5.77% which matures in August 2018. In conjunction with the sale of Cardiff by the Sea, the buyer assumed the mortgage loan totaling $42.2 million at a fixed rate of 5.71%.

During September 2008, the Company obtained mortgage loans in the amount of $23.0 million at a fixed rate of 5.79% and $22.5 million at a fixed rate of 5.81%, secured by the Palisades and Bridgeport communities, respectively. Both mortgage loans mature in September 2018.

During October 2008, the Company repurchased and retired $29.7 million of the Company’s $225 million exchangeable senior notes (“Notes”). The Company repurchased these Notes at a discount to par value and expects to report a gain of approximately $1.1 million from the extinguishment of debt in the fourth quarter of 2008.

The Company has signed a letter of commitment to enter into a new five-year secured line of credit facility with Freddie Mac to replace the existing secured line of credit facility that matures in January 2009. The new secured facility will expand the existing secured facility from $100 million to $150 million, and the new facility will be expandable to $250 million. The Company anticipates that the closing date for the new secured facility will occur by the end of the fourth quarter of 2008.

(3) Co-investments

The Company has joint venture investments (“co-investments”), which are accounted for under the equity method. The co-investments own development projects and operating apartment communities. The following table details the Company's co-investments (dollars in thousands):

	September 30,		December 31,
	2008		2007

Investments in joint ventures accounted for under the equity method of accounting:

Limited partnership interest of 27.2% and general partner interest of 1% in Essex Apartment Value Fund II, L.P ("Fund II")	$	60,866	$	58,419
Preferred limited partnership interest in Mountain Vista Apartments, LLC (A)		-		1,182
Development joint venture		4,997		4,090
		65,863		63,691
Investments accounted for under the cost method of accounting:
Series A Preferred Stock interest in Multifamily Technology Solutions, Inc		500		500
Total co-investments	$	66,363	$	64,191

(A)	The investment was held in an entity that included an affiliate of The Marcus & Millichap Company (“TMMC”), and is the general partner. TMMC’s Chairman is also the Chairman of the Company.

Index

The combined summarized balance sheet for co-investments, which are accounted for under the equity method, is as follows (dollars in thousands).

	September 30,		December 31,
	2008		2007
Balance sheets:
Real estate and real estate under development	$	519,921	$	614,266
Other assets		7,672		16,184

Total assets	$	527,593	$	630,450

Mortgage notes payable	$	298,442	$	322,615
Other liabilities		12,733		24,014
Partners' equity		216,418		283,821

Total liabilities and partners' equity	$	527,593	$	630,450

Company's share of equity	$	65,863	$	63,691

The combined summarized statement of operations for co-investments, which are accounted for under the equity method, is as follows (dollars in thousands).

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Statements of operations:
Property revenues	$	11,906		$	11,761		$	34,232		$	34,596
Operating expenses		(4,565	)		(4,335	)		(13,180	)		(13,805	)
Interest expense		(2,876	)		(3,369	)		(8,205	)		(10,623	)
Depreciation and amortization		(3,308	)		(3,485	)		(9,979	)		(10,431	)

Total net income (loss)	$	1,157		$	572		$	2,868		$	(263	)

Company's share of operating net income		335			322			1,007			421
Company's preferred interest/gain - Mt. Vista		-			-			6,318			2,346
Company's share of net income	$	335		$	322		$	7,325		$	2,767

Through September 30, 2008, the Company has made contributions to a joint venture totaling $5.0 million related to a development project located in Southern California, which was still in the predevelopment stage as of September 30, 2008.

In January 2008, the Company received $7.5 million and recognized $6.3 million of preferred income which is included in equity income in co-investments from the repayment of its investment in Mountain Vista Apartments, LLC.

(4) Notes and Other Receivables

Notes receivables secured by real estate, and other receivables consist of the following as of September 30, 2008 and December 31, 2007 (dollars in thousands):

	September 30,		December 31,
	2008		2007

Note receivable, secured, bearing interest at LIBOR + 4.65%, due July 2008	$	-	$	5,448
Note receivable, secured, bearing interest at LIBOR + 3.38%, due February 2009		12,863		10,999
Note receivable, secured, bearing interest at LIBOR + 2.95%, due April 2009		14,000		14,010
Note receivable, secured, bearing interest at LIBOR + 3.69%, due June 2009		7,328		7,346
Note receivable, secured, bearing interest at LIBOR + 4.75%, due March 2011		7,260		7,128
Other receivables		4,331		4,701
	$	45,782	$	49,632

In September 2007, the Company originated a loan to the owners of an apartment community under development in Vancouver, Washington, with a maturity date of February 2009. The proceeds from the loan refinanced the property and are providing funding for the completion of the 146-unit apartment community. In July 2008, the Company ceased recording interest income and issued a notice of monetary default to the borrower, and the borrower filed for bankruptcy. The Company expects the note will be settled through the foreclosure or sale of the property for full payment of the note.

Index

(5) Related Party Transactions

Other related party receivables consist primarily of accrued payroll costs and management fees due from Fund II totaling $1.0 million and $0.9 million as of September 30, 2008 and December 31, 2007, respectively. Management and other fees from affiliates include property management, asset management, development and redevelopment fees from related parties of $1.3 million for the quarters ended September 30, 2008 and 2007, and $4.0 million and $3.7 million for the nine months ended September 30, 2008 and 2007, respectively. The Company’s Chairman, George Marcus, is also the Chairman of TMMC, which is a real estate brokerage firm. The Company paid $0.2 million and $0 brokerage commissions on the sale of real estate during the three months ended September 30, 2008 and 2007, respectively, and $0.2 million and $1.3 million during the nine months ended September 30, 2008 and 2007, respectively.

As discussed in Note 3, in January 2008, the Company received $7.5 million from an investment held in an affiliate of TMMC and recognized $6.3 million of preferred income which is included in equity income from co-investments.

(6) Segment Information

The Company defines its reportable operating segments as the three geographical regions in which its apartment communities are located: Southern California, Northern California and Seattle Metro. Excluded from segment revenues are properties classified in discontinued operations, management and other fees from affiliates, and interest and other income. Non-segment revenues and net operating income included in the following schedule also consist of revenue generated from commercial properties, recreational vehicle parks, and manufactured housing communities. Other non-segment assets include co-investments, real estate under development, cash and cash equivalents, marketable securities, notes receivable, other assets and deferred charges. The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the three months ended September 30, 2008 and 2007 (dollars in thousands):

	Three Months Ended
	September 30,
	2008			2007
Revenues:
Southern California	$	53,442		$	52,429
Northern California		30,516			25,608
Seattle Metro		18,269			16,355
Other real estate assets		680			620
Total property revenues	$	102,907		$	95,012

Net operating income:
Southern California	$	36,282		$	35,979
Northern California		19,877			16,919
Seattle Metro		12,037			10,680
Other real estate assets		362			300
Total net operating income		68,558			63,878

Depreciation and amortization		(27,952	)		(24,169	)
Interest expense		(19,399	)		(19,459	)
Amortization of deferred financing costs		(686	)		(701	)
General and administrative		(6,524	)		(6,415	)
Management and other fees from affiliates		1,311			1,268
Gain on sale or real estate		2,446			-
Interest and other income		2,847			2,407
Equity income in co-investments		335			322
Minority interests		(5,666	)		(5,088	)
Income before discontinued operations	$	15,270		$	12,043

Index

The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the nine months ended September 30, 2008 and 2007 (dollars in thousands):

	Nine Months Ended
	September 30,
	2008			2007
Revenues:
Southern California	$	159,725		$	155,632
Northern California		88,782			71,122
Seattle Metro		52,355			47,144
Other real estate assets		2,036			1,849
Total property revenues	$	302,898		$	275,747

Net operating income:
Southern California	$	109,582		$	107,608
Northern California		58,002			47,081
Seattle Metro		34,925			31,035
Other real estate assets		860			18
Total net operating income		203,369			185,742

Depreciation and amortization		(82,564	)		(69,036	)
Interest expense		(57,835	)		(57,688	)
Amortization of deferred financing costs		(2,109	)		(2,054	)
General and administrative		(19,600	)		(18,519	)
Management and other fees from affiliates		3,965			3,662
Gain on sale of real estate		2,446			-
Interest and other income		8,048			7,454
Equity income in co-investments		7,325			2,767
Minority interests		(16,929	)		(15,459	)
Income before discontinued operations	$	46,116		$	36,869

	September 30,		December 31,
	2008		2007
Assets:
Southern California	$	1,218,392	$	1,354,818
Northern California		852,061		829,879
Seattle Metro		420,411		353,737
Other real estate assets		51,997		37,338
Net rental properties		2,542,861		2,575,772

Real estate - held for sale, net		15,983		-
Real estate under development		347,979		233,445
Co-investments		66,363		64,191
Cash and cash equivalents		45,956		22,483
Marketable securities		58,614		2,017
Notes and other receivables		46,749		50,536
Other non-segment assets		34,821		31,879
Total assets	$	3,159,326	$	2,980,323

Index

(7)	Net Income Per Common Share

(Amounts in thousands, except per share and unit data)

	Three Months Ended								Three Months Ended
	September 30, 2008								September 30, 2007
				Weighted-		Per					Weighted-		Per
				average		Common					average		Common
				Common		Share					Common		Share
	Income			Shares		Amount			Income		Shares		Amount
Basic:
Income from continuing operations available to common stockholders	$	12,960			25,111	$	0.52		$	9,732		25,165	$	0.39
Income (loss) from discontinued operations		(584	)		25,111		(0.02	)		265		25,165		0.01
		12,376				$	0.50			9,997			$	0.40

Effect of Dilutive Securities (1)		-			364					-		391

Diluted:
Income from continuing operations available to common stockholders		12,960			25,475	$	0.51			9,732		25,556	$	0.38
Income (loss) from discontinued operations		(584	)		25,475		(0.02	)		265		25,556		0.01
	$	12,376				$	0.49		$	9,997			$	0.39


	Nine Months Ended								Nine Months Ended
	September 30, 2008								September 30, 2007
				Weighted		Per					Weighted		Per
				Average		Common					Average		Common
				Common		Share					Common		Share
	Income			Shares		Amount			Income		Shares		Amount
Basic:
Income before discontinued operations available to common stockholders	$	39,185			24,877	$	1.58		$	30,005		24,370	$	1.23
Income (loss) from discontinued operations		(1,417	)		24,877		(0.06	)		25,172		24,370		1.03
		37,768				$	1.52			55,177			$	2.26

Effect of Dilutive Securities (1)		-			305					-		614

Diluted:
Income before discontinued operations available to common stockholders		39,185			25,182	$	1.56			30,005		24,984	$	1.20
Income (loss) from discontinued operations		(1,417	)		25,182		(0.06	)		25,172		24,984		1.01
	$	37,768				$	1.50		$	55,177			$	2.21

(1)

Weighted convertible limited partnership units of 2,184,446 and 2,273,992 for the three months ended September 30, 2008 and 2007, respectively, and 2,224,828 and 2,285,541 for the nine months ended September 30, 2008 and 2007, respectively, and Series Z incentive units of 250,927 and 213,205 for the three months ended September 30, 2008 and 2007, respectively, and 250,514 and 213,045 for the nine months ended September 30, 2008 and 2007, respectively, were not included in the determination of diluted EPS because they were anti-dilutive. The Company has the ability and intent to redeem DownREIT Limited Partnership units for cash and does not consider them to be common stock equivalents.

On or after November 1, 2020, the holders of the $225 million exchangeable notes may exchange, at the then applicable exchange rate, the notes for cash and, at Essex’s option, a portion of the notes may be exchanged for Essex common stock; the original exchange rate was $103.25 per share of Essex common stock. The exchangeable notes will also be exchangeable prior to November 1, 2020, but only upon the occurrence of certain specified events. During the three and nine months ended September 30, 2008 the weighted average common stock price exceeded the current strike price and therefore common stock issuable upon exchange of the exchangeable notes was included in the diluted share count. The treasury method was used to determine the shares to be added to the denominator for the calculation of earnings per diluted share.

Stock options of 28,250 and 45,004 for the three months ended September 30, 2008 and 2007, respectively, and 75,111 and 19,753 for the nine months ended September 30, 2008 and 2007, respectively, were not included in the diluted earnings per share calculation because the exercise price of the options were greater than the average market price of the common shares for the three and nine months ended and, therefore, were anti-dilutive.

The 5,980,000 shares of Series G cumulative convertible preferred stock have been excluded from diluted earnings per share for the three and nine months ended September 30, 2008 and 2007 as the effect was anti-dilutive.

Index

(8) Derivative Instruments and Hedging Activities

As discussed in Note 1, the Company adopted FAS 157 as of January 1, 2008. The Company values forward-starting interest rate swaps at fair value, and based on the fair value hierarchy of valuation techniques, the Company has elected to use fair values determined by Level 2. Level 2 valuation methodology is determined based on inputs other than quoted prices in active markets for identical assets or liabilities the Company has the ability to access as included in Level 1 valuation methodology that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices observable for the asset or liability, such as interest rates and yield curves observable at commonly quoted intervals. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. As of September 30, 2008, forward-starting interest rates swaps are the only assets and liabilities that the Company measured at fair value based on the FAS 157 fair valuation methodology.

As of September 30, 2008 the Company had eight forward-starting interest rate swaps totaling a notional amount of $400 million with interest rates ranging from 5.1% to 5.9% and settlements dates ranging from December 2008 to October 2011. These derivatives qualify for hedge accounting as they are expected to economically hedge the cash flows associated with the refinancing of debt that matures December 2008 through October 2011. The fair value of the derivatives decreased $5.1 million during the nine months ended September 30, 2008 to a liability value of $15.4 million as of September 30, 2008, and the derivative liability was recorded in other liabilities in the Company’s condensed consolidated financial statements. The changes in the fair values of the derivatives are reflected in accumulated other comprehensive (loss) income in the Company’s condensed consolidated financial statements. No hedge ineffectiveness on cash flow hedges was recognized during the quarter ended September 30, 2008 and 2007.

During the second quarter 2008, the Company settled one forward-starting interest rate swaps for a total of $1.8 million in payments to counterparties. The $1.8 million loss on settlement will be amortized over the life of the 10-year secured mortgage loans.

(9) Discontinued Operations

In the normal course of business, the Company will receive offers for sale of its properties, either solicited or unsolicited. For those offers that are accepted, the prospective buyer will usually require a due diligence period before consummation of the transaction. It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process. Essex classifies real estate as "held for sale" when all criteria under FAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (“FAS 144”) have been met.

During February 2007, City Heights Apartments, a 687-unit community located in Los Angeles was sold to a third-party for $120 million. The Company’s share of the proceeds from the sale totaled $33.9 million, resulting in a $13.7 million gain on sale to the Company, and an additional $10.3 million for fees from the City Heights joint venture partner are included in discontinued operations in the accompanying condensed consolidated statements of operations.

In December 2007, the Company sold four communities (875-units) in the Portland metropolitan area and, as a result, has classified the results of operations for these communities as discontinued operations for the three and nine months ended September 30, 2007.

In July 2007, the Company sold the final 2 condominium units at the Peregrine Point property for a gain of $0.1 million net of taxes and expenses. For the nine months ended September 30, 2007, the Company sold 21 condominium units at the Peregrine Point property and recorded a gain of $1.0 million net of taxes and expenses. The Company has recorded the gain on sale of condominiums and operations for Peregrine Point apartments as part of discontinued operations in the accompanying consolidated statements of operations.

During the third quarter of 2008, the Company sold Cardiff by the Sea, a 300-unit community located in Cardiff, California for $71.0 million and St. Cloud Apartments, a 302-unit community located in Houston, Texas for $8.8 million resulting in a combined gain of $46,000. The Company has recorded the gain on sale operations for these two apartment communities as part of discontinued operations in the accompanying consolidated statements of operations.

The Company is in contract to sell Coral Gardens, a 200-unit apartment community located in El Cajon, California in the fourth quarter of 2008 for $19.8 million. This community is classified as held for sale as of September 30, 2008, and as a result, has classified the results of operations for Coral Gardens as discontinued operations.

Index

The components of discontinued operations are outlined below and include the results of operations for the respective periods that the Company owned such assets, as described above.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007

Rental revenues	$	1,677		$	4,594		$	6,528		$	13,416
Interest and other income		-			-			-			290
Revenues		1,677			4,594			6,528			13,706
Property operating expenses		(1,183	)		(2,142	)		(3,594	)		(5,899	)
Interest expense		(545	)		(783	)		(2,087	)		(1,729	)
Depreciation and amortization		(629	)		(1,443	)		(2,434	)		(3,460	)
Minority interests		54			(20	)		128			(226	)
Expenses		(2,303	)		(4,388	)		(7,987	)		(11,314	)
Gain on sale of real estate		46			64			46			79,275
Subordination fees		-			-			-			10,290
Minority interests - OP units		(4	)		(5	)		(4	)		(2,156	)
Minority interests - City Heights		-			-			-			(64,629	)
Net gain on sale of real estate		42			59			42			22,780
								-
Income from discontinued operations	$	(584	)	$	265		$	(1,417	)	$	25,172

(10) Commitments and Contingencies

The Company is subject to various lawsuits in the normal course of its business operations. Such lawsuits could have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2007 Annual Report on Form 10-K for the year ended December 31, 2007 and our Current Report on Form 10-Q for the quarter ended September 30, 2008.

The Company is a fully integrated real estate investment trust (“REIT”), and its property revenues are generated primarily from apartment community operations. Our investment strategy has two components: constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth. Our strong financial condition supports our investment strategy by enhancing our ability to quickly shift our acquisition, development, and disposition activities to markets that will optimize the performance of the portfolio.

As of September 30, 2008, we had ownership interests in 133 apartment communities, comprising 26,790 apartment units. Our apartment communities are located in the following major West Coast regions:

Southern California (Ventura, Los Angeles, Santa Barbara, Orange, Riverside and San Diego counties)

Northern California (the San Francisco Bay Area)

Seattle Metro (Seattle metropolitan area)

As of September 30, 2008, the Company also had ownership interests in nine office buildings and one manufactured housing community (containing 157 sites).

As of September 30, 2008, the Company’s consolidated development pipeline, excluding development projects owned by Fund II, was comprised of five development projects, three predevelopment projects, and five land parcels held for future development aggregating 2,715 units, with total incurred costs of $348.0 million, and estimated remaining project costs of approximately $483.6 million for total estimated project costs of $831.6 million.

Index

The Company’s consolidated apartment communities are as follows:

	As of September 30, 2008					As of September 30, 2007
	Apartment Homes		%			Apartment Homes		%
Southern California		12,225		51	%		12,225		52	%
Northern California		6,457		27	%		6,361		27	%
Seattle Metro		5,338		22	%		5,005		21	%
Total		24,020		100	%		23,591		100	%

Co-investments including Fund II properties and properties included in discontinued operations are not included in the table presented above for both periods presented.

Comparison of the Three Months Ended September 30, 2008 to the Three Months Ended September 30, 2007

Our average financial occupancies for the Company’s stabilized apartment communities or “Quarterly Same-Properties” (stabilized properties consolidated by the Company for the quarters ended September 30, 2008 and 2007) increased 40 basis points to 96.3% as of September 30, 2008 from 95.9% as of September 30, 2007. Financial occupancy is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue. Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions. Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents. We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate. Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates as disclosed by other REITs may not be comparable to our calculation of financial occupancy.

The regional breakdown of the Company’s Quarterly Same-Property portfolio for financial occupancy for the quarter ended September 30, 2008 and 2007 is as follows:

	Three months ended
	September 30,
	2008			2007
Southern California		95.4	%		95.5	%
Northern California		97.8	%		96.8	%
Seattle Metro		96.8	%		95.9	%

The table below illustrates a breakdown of revenues, including revenues attributable to the Quarterly Same-Properties.

			Three Months Ended
	Number of		September 30,				Dollar		Percentage
	Properties		2008		2007		Change		Change
Property Revenues (dollars in thousands)
Same-Properties:
Southern California		57	$	48,237	$	47,701	$	536		1.1	%
Northern California		18		20,080		18,527		1,553		8.4
Seattle Metro		24		16,493		15,349		1,144		7.5
Total Same-Property revenues		99		84,810		81,577		3,233		4.0
Non-Same Property Revenues (1)				18,097		13,435		4,662		34.7
Total property revenues			$	102,907	$	95,012	$	7,895		8.3	%

(1) Includes properties acquired since January 1, 2007, eight redevelopment communities, three office buildings and two development communities.

Quarterly Same-Property Revenues increased by $3.2 million or 4.0% to $84.8 million in the third quarter of 2008 from $81.6 million in the third quarter of 2007. The increase in the third quarter of 2008 was primarily attributable to the increase in scheduled rents from the Quarterly Same-Properties which increased $2.7 million or 3.4% compared to the third quarter of 2007. Average rental rates for Quarterly Same-Property communities were $1,404 per unit in the third quarter of 2008 compared to $1,359 per unit in the third quarter of 2007. Occupancy increased quarter over quarter by 40 basis points or $0.2 million, and delinquency and rent concessions decreased slightly by a combined $0.2 million, and other income was consistent between quarters.

Index

Quarterly Non-Same Property Revenues increased by $4.7 million or 34.7% to $18.1 million in the third quarter of 2008 from $13.4 million in the third quarter of 2007. The increase was attributable to ten apartment communities acquired since January 1, 2007 totaling a $3.5 million increase in revenue compared to third quarter of 2007, eight communities that were in redevelopment totaling a $1.1 million increase in revenue compared to the third quarter of 2007, and two development properties totaling a $0.1 million increase in revenue compared to the third quarter of 2007.

Total Expenses increased $7.0 million or 8.6% to $88.9 million in the third quarter of 2008 from $82.1 million in the third quarter of 2007. Property operating expenses including real estate taxes increased by $3.2 million or 10.3% for the quarter, which is primarily due to the acquisition of ten operating properties, leasing at two development properties since January 1, 2007, and annual increases in salaries and real estate taxes. Depreciation expense increased by $3.8 million or 15.7% for the third quarter 2008 compared to the third quarter of 2007, primarily due to the acquisition of ten operating properties since January 1, 2007.

Gain on sale of real estate for the third quarter of 2008 totaling $2.4 million relates to the sale of the Circle RV park for $5.4 million resulting in a gain of $0.9 million, and $1.5 million of the gain that was previously deferred on the 2005 sale of Eastridge Apartments. The $1.5 million gain recognized is equal to the estimated fair value of seven condominium units received in satisfaction of the note receiv